Jim Goodnight makes no effort to hide his disdain for Wall Street. The founder and CEO of SAS Institute, the world’s largest privately-held software company, with revenues of $750m, pours forth on the downside of a public listing the quarterly reporting treadmill, the power of stock market analysts to determine a company’s destiny, the compulsion to deliver growth for growth’s sake and profits for shareholders’ sake, the threat of extinction through acquisition, and the dilution of control and of the power to set the ethics and culture of the company. The list goes on. In common with scores of other large, fiercely independent technology companies, SAS has steered well clear of any stock exchange, championing the demonstrable benefits of being internally-owned. Such companies compete just as fiercely in the marketplace against their publicly-listed counterparts but, within their own walls and in their relationships with their customers, they are often run along very different lines. Of course all companies start out that way wholly-owned by founders and early investors. But the companies that stay private once they pass $50m are an idiosyncratic group. Some, of course, missed the opportunity for a stock market listing either their profitability and growth profile was all wrong, or when it was right, the stock market was unreceptive to technology offerings. Software access company Attachmate and database and tools company Cincom are just two examples.
Inability to let go
But the founders who choose to retain the vast majority of their company’s equity usually do so for a combination of two reasons: Principle and an inability to let go. They argue, as often as not, that customers and employees benefit greatly by the company being focused on their interests rather than on maximizing shareholder value. However they are also aware of the negative aspects of independence that stem almost exclusively from not having liquidity in their shares. Out of character with that model are Packard Bell NEC Inc and Perot Systems Corp. Packard Bell NEC, the Sacramento, California-headquartered PC giant, currently in the process of trying for a second time to list on Wall Street. It is now owned 49% by Japan’s NEC and 12.6% by France’s Groupe Bull. Management and employees hold a large part of the remainder. Packard Bell had estimated revenues of about $8bn in 1996, but many analysts think it has struggled to sustain that level of sales since. What Packard Bell does have in common with almost all private companies is a paranoia about making any of its financial numbers public. Around the world, the private status of companies means their financial performance is shrouded in mystery. Only when the lure of a stock listing becomes too great and companies begin considering an initial public offering (IPO) do they start to leak numbers to customers, analysts and the press as is currently the case at IPO prospect Perot Systems, the computer services giant, and at engineering software firm Bentley Systems Inc.
Important implications
However, the majority of companies are privately held because they like it and want to keep it that way. But their corporate customers and business partners should realize that there are important implications of their private status. Above all, independent companies stress that they can provide a better ‘customer experience’. Employees at private companies say that their ability to forge and maintain a closer relationship with the customer flows from the security and consistency of a private corporate culture. Generous benefits other than salary and a genuine feeling of community means staff turnover is usually very low. This means the customer is often presented with a familiar face. SAS Institute, by far the largest company that specializes in decision support and data warehousing software, is not exceptional in claiming its staff and customer retention is much higher than any of its publicly-listed rivals. The company maintains a 98% renewal rate for its software contracts, although unlike many of its rivals the software is bought on an annual lease basis. And anecdotal evidence comes close to supporting that, with customers such as the UK’s Royal Bank of Scotland complaining about little other than price. With less stress on keeping expenses lean and profit margins juicy, private companies are often able to plow a much larger proportion of revenues back into product development. While a public company such as Oracle Corp spends about 10% of the cash it generates on R&D, SAS has for the past few years channeled 32% of sales back into development. Again, that is the kind of commitment that customers love.
Downside
But the downside of private status is equally visible. And in some cases it represents a competitive disadvantage and an unacceptable set of risk factors. Chief among these problems is a lack of share liquidity. Without the prospect of cashing in share options and gifts, many seasoned executives and technical experts will shy away from private companies. If they are unable to raise capital by issuing equity, private companies often have to rely on loans from banks and other lenders that are far more conservative than investors. That means when extra investment is required as the end of a product cycle looms or when there is a need for rapid international expansion, the cash is often not there. It also means that companies cannot use shares to expand through acquisition. Both of those aspects manifest themselves in the fact that growth is often much slower at private companies. Profitability is another matter. Because private companies make little or no timely disclosure of financial information, there is little for analysts to go on when trying to assess a company’s profits or losses. In most cases the income is modest, but some think there are a few exceptions. In the case of desktop publishing software market leader Quark, profit margins are estimated to be as high as 50% of revenues. On the other side of the bottom line, analysts reckon Packard Bell has been quietly losing large amounts of cash for two years. For the customers of public companies, the lack of evidence of financial viability can raise some serious questions when important contracts are on the table. Had WordPerfect been a public company, its financial deterioration during the early 1990s might have caused many customers to side-step its word-processing software even more quickly than they did. To give it its due, WordPerfect did look closely at an IPO, but a lack of consistency in its numbers and a need for its owners to solve a problem characteristic of private companies, caused a sell-out to Novell.
Succession
And then there is the problem of succession. What happens when the founders of private companies are no longer around? The relative youth of the computer industry means that is not yet a common occurrence. But the first few companies are reaching that stage and what they encounter is a serious dilemma. If the founders own almost all of the shares then, typically, these are inherited by his or her family. In order to pay the resulting inheritance taxes, though, the new owners have to sell a large part of the company either in the form of a stock market flotation or as a sale to another computer company, maybe even a rival. In either case, it can mean the end of the road for the corporate culture that was lovingly created by the founders, and the demise of the job security enjoyed by loyal employees. In the case of German company Software AG, the founder Peter Schnell first took the database software vendor public on Wall Street in the 1980s, before he grew disillusioned by the experience and bought the company back through personal bank loans. Then in 1995, to protect it from the negative implications of a large part of the company passing to family control, he handed his 99% holding to a charitable trust. Now with Schnell in retirement and the company desperately in need of investment capital, Software AG has been forced to sell its US operation to the local management team and to seek a re-listing on Wall Street. But people who ask Jim Goodnight about succession are told to mind their own business. Recently, he said that he is content just programming, playing golf and running the company, blissfully free from analyst and press interference.
This article originally appeared in Computer Business Review, which in the June 1998 issue, ranks the top 50 largest privately- held information technology companies by annual revenues.
